While the growth of closed-end funds (CEFs) is slowing, banks and insurers seem to perceive CEFs as attractive investments in the current low-interest rate environment.

According to Fitch Ratings, banks and insurance companies have increased financing to municipal and taxable CEFs to $46.9 billion, which is up from $14.9 billion in 2007. The funds were used primarily to refinance funds' auction-rate preferred shares (ARPS) and increase leverage in taxable funds starting in 2009.

However of the $62.2 billion ARPS outstanding in 2007, only $12.3 billion remain, which limits refinancing opportunities. At the same time, “CEFs may seek to add new leverage if funds' portfolio values increase,” Fitch said in a press release.

Fitch says that the CEF sector performed well during the financial crisis from 2008-'09 due to their regulatory framework, which limits leverage and makes CEFs relatively safe and capital-efficient investments. In addition, institutional financing for CEFs replaces frozen ARPS, which were retail products.

“Institutional lending to CEFs has been gaining wider acceptance, and the entry of new lenders and new lending products has generally resulted in reduced costs for CEFs,” Fitch said in a press release. “Moreover, institutional borrowing is more efficient and less time consuming for CEFs than the process of marketing securities to retail investors.”

Banks provide financing to CEFs directly through credit facilities, margin loans, reverse repos and variable-rate municipal term preferred shares, as well as indirectly through liquidity support to asset-backed commercial paper conduits, variable-rate demand preferred shares, and tender option bonds. Insurance companies fund CEFs primarily through privately placed notes and preferred shares, Fitch said.

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